Capital Market Assumptions - Q1 2018

09-Feb-2018

By BlackRock Investment Institute

We have upgraded our expectations for US and eurozone growth in our updated capital market assumptions (CMAs). We also dig into our outlook for global yield curves after the most recent bout of curve flattening in the US. We then show our five-year expectations for excess equity returns over cash.

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Quarterly update

The US yield curve has flattened over much of the past year, spooking some investors along the way. Yet we see this move as a natural consequence of the structural factors limiting how high interest rates can rise relative to the past. On a five-year horizon, we see scope for long-term Treasury yields to climb mostly in line with short-term yields. This suggests the yield curve’s current shape should remain fairly steady – even if the path higher might be a bumpy one.

We have raised our five-year expectations for US gross domestic product growth to 2.25% (from 2.0%) due to the fiscal stimulus provided by the tax overhaul and a possible increase in government spending. We also raised our eurozone growth forecast to 1.5% from 1.25% due to improved long-run trend growth. That resulted in higher expected returns for real estate, but richer valuations overwhelmed the potential return boost for equities.

We compare our expected US and eurozone equity returns with cash and reaffirm our preference for equities on a five-year horizon. Even with the rise in valuations, expected excess returns remain in the US and are higher in Europe. We lay out our thinking on how structurally lower interest rates shape our assessment of equity valuations. We have raised our return expectations for emerging market (EM) stocks after bringing our valuation methodology for this asset class in line with how we calculate fair value for developed market (DM) equities.

We return expectations for DM equities have dropped after the broad gains in the fourth quarter pushed valuations higher. Our return outlook for government bonds and investment grade credit is unchanged, but return expectations on long-dated bonds fell further. We see negative returns on government bonds in many regions over the next five years. This means equities and private market assets look more attractive on a relative basis, in our view. The asset allocation breakdown in our model portfolios has not changed this quarter as the relative return and risk outlook is broadly the same.

BlackRock’s Long-Term Capital Market Assumption Disclosures: This information is not intended as a recommendation to invest in any particular asset class or strategy or product or as a promise of future performance. Note that these asset class assumptions are passive, and do not consider the impact of active management. All estimates in this document are in US dollar terms unless noted otherwise. Given the complex risk-reward trade-offs involved, we advise clients to rely on their own judgment as well as quantitative optimisation approaches in setting strategic allocations to all the asset classes and strategies. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. If the reader chooses to rely on the information, it is at its own risk. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, or tax advice. The outputs of the assumptions are provided for illustration purposes only and are subject to significant limitations. “Expected” return estimates are subject to uncertainty and error. Expected returns for each asset class can be conditional on economic scenarios; in the event a particular scenario comes to pass, actual returns could be significantly higher or lower than forecasted. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making an investment decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact future returns.

Index Disclosures: Index returns are for illustrative purposes only and do not represent any actual fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

General Disclosure: This material is prepared by BlackRock and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2018 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

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